Secured Cards: Frequently Asked Questions

Oct 15, 2016 | Odysseas Papadimitriou, WalletHub CEO

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Secured credit cards are designed for people with bad, limited or no credit history and use a security deposit that doubles as a credit limit to protect issuers from what are considered to be risky customers. If you do not have an outstanding balance at the time you decide to close your secured credit card, the entire security deposit is returned to you. Because issuers incur little risk with secured cards, these products typically also have low fee structures and minimal requirements for approval. All you generally need to do to open a secured credit card is provide a valid Social Security Number (SSN) and, of course, place the refundable security deposit.

Using a secured credit card is ultimately a great way to cost-effectively build or rebuild a solid credit history since secured cards report to the major credit bureaus in the same manner as any other credit card. In fact, no distinction is made between secured and unsecured credit cards on a credit report. Finally, since you can add to your deposit over time and thereby increase your spending limit, a secured card can also provide all the spending power you might need.

Who should apply for a secured credit card?

If you are new to credit, or have had some credit trouble in the past, a secured credit card is a great option for you. No matter what your credit is, you will get approved for a secured card.

No or Limited Credit History: Without credit history to serve as proof of your fiscal responsibility, it’s unlikely that you will get approved for a regular (i.e. unsecured credit card). Credit card companies have no reason to believe you would pay them back for the money you’d spend with an unsecured card, after all, because you don’t have a track record of doing so. However, you shouldn’t have any problem opening a secured credit card, given that the security deposit you are required to place protects issuers against default. By using a secured credit card responsibly (i.e. making on-time payments), the credit history you build should be sufficient to qualify you for an unsecured credit card. You might be surprised at the number of consumers who fall within this category, as it not only includes college students and recent immigrants, but also widows and divorces whose credit may have been under their spouse’s name.

Damaged Credit History:If you have bad credit (no matter how bad it may be), a good way to start rebuilding it is through a secured credit card account. Your spending limit with a secured credit card is equal to the deposit you place in opening it, which means both that approval is basically guaranteed because your issuer isn’t incurring any risk and that you won’t be able to spend beyond your means. If you’re worried about making your payments or falling into bad habits, you can still open a secured credit card and activate it without ever actually using it. Even though there is no activity on your account, you’re still reported to the credit bureaus as being on time with your payments (you can’t be late since you didn’t have any to make in the first place). Since you will constantly be current on your payments, you will continue to be reported as being in good standing on your account, therefore improving your credit score. The only thing you have to do is remember to pay your membership fee once a year, and the rest will take care of itself.

Plastic-necessary purchases: Secured cards are also great for people who want to be able to rent cars and book hotel rooms as well as shop online but don’t trust themselves to use an unsecured credit card.

What are the requirements for secured card approval?

In addition to placing a security deposit of at least $200 - $300, applicants are required by law to submit certain information for identity and income verification purposes. Many individual issuers have instituted their own supplemental secured credit card requirements as well. Altogether, there are three types of information that may be evaluated on the way to secured credit card approval:

Basic Information: All issuers require applicants to provide their name, contact info (including a non-PO Box U.S. address), Social Security Number, and all other basic information requested on the account application.

Income Information: All issuers require applicants to list their income in order to determine whether or not they can afford a new credit card.

Credit Data: Certain issuers will not approve applicants who are delinquent on other credit card and loan accounts and/or applicants who have recent bankruptcies on their credit reports.

How can I get a secured credit card?

You can get a secured credit card by going to your bank or credit union and asking for an application. However, not all banks and credit unions offer secured cards. You can also compare secured credit cards online and apply for one based on your comparison shopping. Annual fees, set-up fees and APRs vary from card to card, so it’s important to shop around to get the best deal.

How much should I deposit on a new secured credit card?

Most secured credit cards require a deposit of at least $200 and may limit deposits to $5,000 or $10,000. You can therefore deposit any amount in that range. It is important to note that the amount of your secured card deposit will serve as your credit limit, so the higher the security deposit you place, the more spending power you will have. Lenders also view lots of available credit favorably, so even if you do not have the cash to make a large deposit now, adding to your initial deposit over time might be a good idea.

Are there secured credit cards that report to credit bureaus?

Yes, all major secured credit cards report usage information to the major credit bureaus and can therefore help you build credit. In fact, secured cards are indistinguishable from unsecured cards on your credit reports. Since secured cards are easier to get approved for than “normal” credit cards, placing a deposit on a secured card is one of the most efficient ways to begin the credit building process.

What’s the best way to use a secured credit card in order to build credit?

Our recommendation is that you pay your secured credit card bill in full every month in order to both avoid any additional charges and make the most out of your card in terms of building your credit score.

“We used a secured credit card to help our son get his first credit card,” says Mary Beth Pinto, a professor of marketing at Penn State. “We wanted him to show regular consistent payments - so that he could build a credit history. We paid $500 and his limit was only $500 on the card. It was a wonderful lower risk way for him to establish credit - and I did not have to co-sign the card.”

If you don’t think it will be possible to pay your bill in full every month but you still need a way to rebuild your credit score, we recommend that you open and activate your secured card but don’t actually use it. Even though there will be no activity on your account, you will still be reported to the credit bureaus as being on time with your payments (you can’t be late since you didn’t have any payments to make in the first place).

Do I need to actually use my secured card in order to improve my credit?

No, you do not. After credit trouble, some people may be worried that they won’t be able to make their payments on their secured credit card, or may not trust themselves to use their credit card responsibly. Fortunately, you can open a secured credit card account, activate it, and still rebuild your credit even if you don’t use it. Even though there is no activity on your account, you’re still reported to the credit bureaus as being on time with your payments (you can’t be late when there’s no payment due). Since you will constantly be current on your payments, you will continue to be reported as being in good standing on your account, therefore improving your credit score. The only thing you have to do is remember to pay your membership fee once a year, and the rest will take care of itself.

How much will my credit score improve each month with a secured card?

It’s impossible to determine exactly how much secured card use will benefit your credit standing on a monthly basis, and anyone who tells you otherwise is just wrong. Much ultimately depends on the nature of your starting point as well as how you manage the secured card in question. Your credit score will improve faster the more available credit you have (which you can control by submitting a larger initial security deposit or adding to it over time) and if you routinely make purchases that you pay in full by your monthly due date.

With that said, we can give you a very general sense of what credit score gains you can expect with a secured card. Just consider that secured credit cards are most often used by people who have bad/damaged credit (i.e. a score between 300 and 619) and secured card users can typically qualify for an unsecured credit card for fair credit within 12-18 months (i.e. they’ll have a score between 620 and 660 by then). That means a secured card has the potential to improve your credit score by as many as 150 or so points over 18 months. But let us emphasize again that the extent to which a secured card benefits your credit standing will depend on your financial situation when you begin use as well as your card management from there on out.

What are the fees/risks associated with a secured credit card?

Secured credit cards usually have a membership fee that is assessed either annually or monthly. Some secured cards also come with an additional one-time fee for setting up an account. The fees and APRs for secured credit cards vary dramatically depending on the card, so it pays to investigate all your options. Our basic rule of thumb is to choose whichever card has the lowest fees, regardless of branding or issuing institution.

“Oftentimes, smaller local banks and credit unions are more willing to make a bet on a marginal customer,” says Larry D. Compeau, professor of consumer studies at Clarkson University. “Don’t assume you only have the choice being offered to you.”

A risk you should consider before getting a secured credit card is the possibility that you may lose your deposit if you default on your payments. You will be charged a late fee whenever you miss a payment on your credit card bill. Should the late fees become more than you can keep up with, you will default on your card and your credit card company will take your deposit. If you are worried about making your payments on time, you can avoid this situation by signing up for ACH. This will ensure that your payments are automatically withdrawn from your checking account each month without you having to think about it.

Our recommendation is that you pay your secured credit card bill in full every month in order to avoid any additional fees and make the most out of your card in terms of building your credit score. If you don’t think this is possible but still need a way to rebuild your credit score, we recommend that you open and activate your secured card, but don’t actually use it. Even though there will be no activity on your account, you will still be reported to the credit bureaus as being on time with your payments (you can’t be late since you didn’t have any to make in the first place).

How do I move from a secured credit card to an unsecured credit card?

Your credit improvement timetable will depend on the extent of the damage you’re rebuilding from as well as how responsibly you use your secured card. In most cases, if you make on-time payments every month and maintain low credit utilization, your credit standing will improve enough for you to qualify for an unsecured credit card (i.e. you’ll have fair credit) after about 12-18 months. If, on the other hand, you continue to max out your credit cards or are unable to make payments by your monthly due date, you’ll simply incur more and more damage, thereby setting back your credit improvement efforts substantially.

With that said, there are three likely scenarios for making the transition from a secured credit card to an unsecured credit card once you’ve proven your reliability and improved your credit score. The first is that another credit card company will take notice of your credit building efforts and will offer you an unsecured credit card, either online or by mail. Should you apply and garner approval for such a card, you will be able to close your secured card account if you need the security deposit back, or more preferably, keep the account active in order to reap the credit scoring benefits while shifting your purchasing to your new card.. If you decide to close your secured account, your security deposit will be returned to you (likely via check), minus any outstanding balances that remain.

Another possibility is that your credit card company will offer you a credit limit increase on your secured credit card. In this scenario, your credit line will be increased above the amount of money you deposited, converting your secured credit card into a partially secured credit card. You will not get your deposit back until you close your now partially secured credit card completely with a zero balance.

The third possibility is that the credit card company will convert your existing secured credit card into an unsecured credit card without closing the account. In this case, you could either receive a check for your entire security deposit (as long as you carry zero balance on the card) or you could receive a statement credit in which your deposit is credited to your new unsecured account. A statement credit is rare, however, because credit card companies want to avoid having a customer carrying a negative balance. You could have a negative balance if, for example, you were carrying a balance of $150 on your secured credit card and then received a statement credit for your entire deposit of $400, bringing your balance to -$250.

Image: wk1003mike/Shutterstock

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